Saturday, June 29, 2013

“We know at $1,200 an ounce, the majority of gold mines can’t even mine gold profitably. So gold is now trading for less than the cost of producing it, and of course in order to produce it you have to own a gold mine, which is very hard to do. So the price of gold can’t stay down here for a long period of time, because then the gold companies will shut down and there will be no supply.”

Wednesday, June 26, 2013

The Japanese stereotype of excessive courtesy is being confirmed by the actions of prime minster Shinzo Abe who is giving the world a free and timely lesson on the dangers of overly accommodative monetary policy. Whether or not we benefit from the tutorial (Japan will surely not) depends on our ability to understand what is currently happening there.

For now most economists still believe that Abe has stumbled upon the magic elixir of economic revitalization. His commitment to pull his country out of the mud by doubling the amount of yen in circulation, and raising the nation's official inflation rate to 2%, had conferred rock star status on the formerly bland career politician. But just one year after his first critical raves arrived, the audience is heading for the exits. As it turns out, the Japanese miracle may be a simple tale of confidence easily gained, and just as rapidly lost.

In many ways the 75% nine month rally in the Nikkei 225 (that began when Abe was elected prime minister in September 2012), and the subsequent crash that began on May 22, is not all that different from the turbocharged rally, and spectacular crash, that occurred in technology heavy Nasdaq more than a dozen years ago here in the United States.

At the time that Pets.com (the company behind the iconic Sock Puppet) made its IPO, other high flying tech stocks had racked up 1000% gains. While investors scratched their heads, pundits offered reasons why common sense no longer applied to the new economy. We were told that valuations, revenue and profits no longer mattered. And to an extent that now seems absurd, the investing establishment bought into the insanity. But then a funny thing happened, investors woke up and realized that they had nothing but a handful of magic beans that couldn't grow a beanstalk. When the fog lifted, stocks plummeted...Wile E. Coyote style.

This time around investors in the Japanese market were similarly deluded by fairy tales. Leading economists told them that Japan could cheapen its currency to improve trade, use inflation to create real growth, increase prices to encourage spending, and drastically increase inflation without raising interest rates. In short, monetary policy was seen as substitute for an actual economy.

Sunday, June 23, 2013

As usual the Federal Reserve media reaction machine has fallen for a poorly executed head fake. It has been fooled by this move many times in the past and for its efforts it has tackled nothing but air. Yet right on cue, it took the bait once more. Somehow the takeaway from Wednesday's release of the June Fed statement and the Bernanke press conference is that the Central bank is likely to begin scaling back, or "tapering," it's $85 billion per month quantitative easing program sometime later this year, and that the program may be completely wound down by the middle of next year.

Although this scenario is about as likely as an NSA-sponsored ticker tape parade for whistle blower Edward Snowden, all of the market segments reacted as if it were a fait accompli. The stock market, convinced that it will lose the support of ultra-low, long-term interest rates, and the added consumer spending that results from a nascent housing bubble, sold off in triple digits. The bond market, sensing that its biggest and busiest customer will be exiting the market, followed a similarly negative trajectory. The sell -off in government and corporate debt pushed yields up to 21 month highs. In foreign exchange markets the dollar rallied off its four-month lows based on the belief that Fed tightening will support the currency. And lastly, the gold market, sensing that an end of quantitative easing would eliminate the inflationary fears that have partially fueled gold's spectacular rise, sold off nearly five percent to a new two and a half year low.

All of this came as a result of Bernanke's mild commitments to begin easing back on permanent QE sometime later this year if the economy continued to improve the way he expected. The Chairman did not really elaborate of what types of improvements he had seen, or how much farther those unidentified trends would need to go before he would finally pull the trigger. He was however careful to point out that any policy shift, be it for less or more quantitative easing, would not be dependent on incoming data, but on the Fed's interpretation of that data. By stressing repeatedly that its data goalposts were "thresholds rather than triggers" the Fed gained further latitude to pursue any stance it chooses regardless of the data.

Yet the mere mention that tapering was even possible, combined with the Chairman's fairly sunny disposition (perhaps caused by the realization that the real mess will likely be his successor's problem to clean up) was enough to convince the market that the post-QE world was at hand. This conclusion is wrong.

Although many haven't yet realized it, the financial markets are stuck in a "Waiting for Godot" era in which the change in policy that all are straining to see, will never in fact arrive. Most fail to grasp the degree to which the "recovery" will stall without the $85 billion per month that the Fed is currently pumping into the economy.

What exactly has convinced the Fed that the economy is improving? From what I can tell, the evidence centered on the rise in stock and real estate prices, and the confidence and spending that follow. But inflated asset prices are completely dependent on QE and are likely to reverse course even before it is removed. And while it is painfully clear that expectations about QE continuance have made a far bigger impact on the stock, bond, and real estate markets than any other economic data points, many must be assuming that this dependency will soon end.

Those who hold this belief have naively described QE as the economy's "training wheels," (in reality the program is currently our only wheels.) They are convinced that the kindling of QE will inevitably ignite a fire in the larger economy. But the big lumber is still too dampened by debt, government spending, regulation, and high asset prices to catch fire. So all we have gotten is smoke. A few mirrors supplied by the Fed merely completed the illusion. The larger problem of course, is that even though the stimulus are the only wheels, the Fed must remove them anyway as we are cycling toward the edge of a cliff.

Although Bernanke dodged the question in his press conference, the Fed has broken the normal market for mortgage backed debt. While it's true that the Fed only owns 14% of all outstanding MBS (the "small fraction" he referred to in the press conference) it is by far the largest purchaser of newly issued mortgage debt. What would happen to the market if the Fed were to stop buying? There are no longer enough private buyers to soak up the issuance. Those who do remain would certainly expect higher yields if the option of selling to the Fed was of table. Put bluntly, the Fed is the market right now and has been for years.

A clear-eyed look at the likely consequences of a pull-back in QE should cause an abandonment of the optimistic assumptions behind the Fed's forecast. Interest rates are already rising rapidly based simply on the expectation of tapering. Image how high they would soar if the Fed actually tried to sell some of the mortgages it already owns. But the fact is, the mere anticipation of such an event has already sent mortgage rates north of 4%, and without more QE from the Fed in the could soon exceed 5%. Such an increase would deliver a devastating blow to the housing market. More foreclosure will hit just as higher home prices and mortgage rates price legitimate buyers out of the market. Housing prices will fall to new post bubble lows, sinking the phony recovery in the process. The wealth effect will work in reverse, spending and confidence will fall, unemployment will rise, and we will be back in recession even before the Fed begins to taper.

In fact, the back-up in mortgage rates seen over the last month has already produced pain in the financial world, with banks reporting a rapid collapse in refinancing applications. With personal income and wage growth essentially stagnant, individual buyers are extremely dependent on the affordability that ultra-low rates provide. A 50% increase in mortgage rates (an increase from 3.25% to 5%) would price a great many buyers out of the market. Higher rates would also cool much of the housing demand that has been coming from the private equity funds that have been a huge factor in pushing up real estate prices in recent years. Falling home prices would likely trigger a new wave of defaults and housing related bankruptcies that had plunged the economy into recession five years ago.

A similar dynamic would occur in the market for U.S. Treasury debt. Despite Bernanke's assurances that the Fed is not monetizing the government's debt, the central bank has been buying nearly 70% of the new issuance in recent years. Already rates on 10 year treasury debt have crept up by more than 50% in less than two months, to over 2.4%. Any actual decrease or cessation in buying (let alone the selling that would be needed to unwind the Fed's multi-trillion dollar balance sheet) would place the Treasury market under extreme pressure. Since low rates are the life blood of our borrow and spend economy, it is highly likely that higher rates will lead directly to lower stock prices, lower GDP growth, and higher unemployment. Since rising asset prices, and the confidence and spending they produce, are the basis for Bernanke's rosy forecast, new lows in house prices and a bear market in stocks will quickly reverse those forecasts.

Higher interest rates and a slowing economy will be a a disaster for Federal budget deficits. An increase in unemployment and a decrease in tax will hit just as rising rates make it more expensive for the Fed to finance new and maturing debt. Also the profit checks Fannie and Freddie have been paying the Treasury will turn into bills for losses, as a new wave of foreclosures comes crashing down.

It's fascinating how the goal posts have moved quickly on the Fed's playing field. Months ago the conversation focused on the "exit strategy" it would use to unwind the trillions of bonds and mortgages that it had accumulated over the last few years. Despite apparent improvements in the economy, those discussions have given way to the more modest expectations for the "tapering" of QE. I believe that we should really be expecting a "tapering" of the tapering conversations.

I expect that the Fed will continue to pantomime that an Exit Strategy is preparing for a grand entrance, even as their time line and decision criteria become ever more ambiguous. The Fed's next big announcement will likely be to increase, not diminish QE. After all, Bernanke made clear in his press conference that if the economy does not perform up to his expectations, he will simply do more of what has already failed.

Of course, when the Fed is forced to make this concession, it should be obvious to a critical mass that the recovery is a sham. Investors will realize that yeas of QE have only exacerbated the problems it was meant to solve. When the grim reality of QE infinity sets in, the dollar will tank, gold will soar, and the real crash will finally be upon us. Buckle up.

Saturday, June 8, 2013

The most puzzling part of the investment business is seeing how the vast and largely economically illiterate masses interpret any given piece of news. Take the recent gold selloff: many large players were motivated to sell by news that Cyprus will have to liquidate its gold stockpiles to pay off acute debt obligations. But just a moment's reflection shows this reaction to be knee-jerk.

The real story behind Cyprus' deal has much more profound ramifications - and they are positive for gold.

The Right Lens

The reaction to Cyprus' forced gold sale re-affirms my belief that most Western investors remain in a state of extreme anxiety. This leaves no room for the kind of nuanced analysis that leads to wise long-term investment decisions.

The important point is not that Cyprus has to sell €400 million worth of its gold reserves, but rather the circumstances of the sale and the potential buyers that will emerge.

Gold Demanded, Not Divested

After all, this isn't a strategic investment decision by the Central Bank of Cyprus to divest itself of the yellow metal. In fact, local officials have gone on record saying any gold liquidation is a last resort. Cyprus wants to keep its gold - as has every nation in the West since the fiat money system started breaking down in the mid-2000s.

The only reason a gold sale is being proposed is that Cyprus finds itself at the height of its sovereign debt collapse. It has a long line of creditors but scant capital to pay them back. Gold is among the island nation's only liquid assets available to be repossessed. This is, in fact, a ringing endorsement of the enduring value of gold when a banking system disintegrates.

Won't Hit the Market

Still, some may be concerned about the price effects of gold sales by sovereigns. After all, Cyprus is just the tip of the iceberg. Lower down, the iceberg contains many European nations that are well-stocked with gold but that have debts orders of magnitude more hefty than Cyprus, e.g. Italy, France, Portugal, and Spain.

Again, when viewed correctly, this reality is at worst neutral for gold investors.

When a sovereign is forced to sell its gold, the reason is to pay other sovereign creditors. With regard to the spot price and global marketplace for the metal, that sale is "off the books." It merely cancels some IOUs, and the gold is shifted between central banks. It is not that this transaction has no market effects, but at the end of the day, the impact on gold's trading price is minimal.

Redemption

While Cyprus' payments to its European creditors is unlikely to change the fundamental landscape for gold, it represents a coming trend that will reshape everything we take for granted.

A legacy of its former wealth, the developed world is gold-rich and capital-poor. Emerging markets are in the opposite position. As I have long explained, we are undergoing a prolonged foreclosure by the emerging markets (centered on China) on the developed world (centered on the US). Greece, Cyprus, Ireland, Iceland... these are the marginal cases that are the first movements in what will be a global realignment of the remaining Western capital to the East.

China and its cohorts have a pile of IOUs, and the Western nations have a pile of gold. As push comes to shove and the ongoing Eastern shift into hard assets translates into spiking interest rates and runaway asset prices in the West, the Western governments' reserves will quickly become illiquid; in other words, they'll be about as desirable as Greek government bonds are today. If history is any indicator, Eastern governments may continue to offer lifelines - but they will demand collateral that can't be devalued. As Western governments inevitably continue their profligacy, the loans will be called and the gold stockpiles will board ships across the Pacific.

Renaissance

This entire process of breakdown and redemption will serve as a first-hand lesson in the enduring value of the yellow metal. And, at its conclusion, the nations with the capital will also be the ones with large gold stockpiles.

This bodes well for the price of gold. As bullion moves from weak hands to strong, the odds of Cypriot gold seeing the light of day again in our lifetimes are slim. Wealthy creditor nations have the resources to protect their gold. Bankrupt debtor nations do not.

It also bodes well for the re-monetization of the precious metals. Larger gold reserves will give Eastern nations the confidence they need to finally abandon the US dollar-based reserve system and put their currencies on a sounder footing.

Cyprus, Greece, et al. might be foreign countries, but their problems are exactly the same as those facing the US. The key difference is that the US is in a unique position to prolong and exacerbate its debt situation until it faces the largest sovereign debt collapse in human history. With the US dollar at the center of the global money system, I expect that this will shake confidence in fiat currencies for generations to come.

The Long View

Fair-weather investors in gold jump at the first sign of turbulence because they do not have a clear concept of the monetary transformation that is taking place. They see other gold investors as greater fools who they must beat to the safety of US dollars when the music stops. Fortunately for those who know better, these momentary panics allow us to buy their gold at steep discounts.

Many of you are aware of this already. Our phones at Euro Pacific Precious Metals have been ringing off the hooks, especially given our new products on offer.

So the fools sell on news of Cyprus, while the rest of us see it as the kickoff of a historic Great Redemption of gold from West to East.

Thursday, June 6, 2013

"Investor Peter Schiff invests as if the U.S. economy will collapse, which involves moving money offshore, a move he calls the most patriotic way for an American to invest. Dow Jones Newswires' Meena Thiruvengadam reports on a man who has become a financial fortune teller for Tea Party activists and who predicts an evisceration of the American dream."

Sunday, June 2, 2013

Peter Schiff, the boss of Euro Pacific Capital, author and financial commentator, is not backing away from doomsday predictions about the U.S. economy.

The way Schiff sees it, either the Fed stops QE and starts selling the Treasurys and mortgage-related assets on its balance sheet, thus triggering a recession, or else faces an inevitable, even-worse, currency crisis.

“I am 100% confident that the crisis that we’re going to have will be much worse than the one we had in 2008,” Schiff said in an interview.

Schiff is dismissive of the general sense that the pace of the U.S. recovery is picking up.

“The whole idea that the U.S. economy is recovery is based entirely on rising asset prices,” Schiff said.

Asset prices are only rising because rates are low. As soon as rates go back up, asset prices will come back down, he argued.

While economic growth rebounded in the first quarter to a 2.4% annual rate after a dismal fourth quarter, the savings rate dropped and disposable income also declined, he noted.

“Incomes are declining, savings are being depleted, those aren’t good signs,” Schiff said.

Schiff just scoffs at suggestions the economy faces the threat of deflation. Indeed, he suggest that the government is deliberately under-reporting inflation.

“All of the things we buy are getting expensive,” he said.

Talk of deflation is just a way for the Fed to win support for higher inflation needed to inflate debt burdens away, he said.